Picture yourself sitting at the desk of your real estate company trying to figure out how you are going to sell over 20,000 acres of land in Michigan, 10,000 acres in Florida, and seven other big lot real estate investments that you made over the last 10 years in preparation for retirement.
Now, imagine that the date is January 1958.
The only way you had a chance to do all that selling back then was to hire real estate sales people in each state, maybe as many as nine different firms, hire possibly just as many PR firms to help you put together nine different sales programs that would help you sell all of that land and then pray that you could handle all the traveling that was necessary to get it all done (remember, jets were just beginning to be used in those days). I get exhausted even thinking about it.
Well, this was just the fix several investors found themselves contemplating back then. As the story was told to me, one of the investors had a high powered brother (or maybe it was an uncle, so don't hold me to the brother part) that had an idea of how to help. He told his brother that he wanted to form a mutual fund and have it buy all the land that his brother had for sale. Then the fund would be registered with the Securities and Exchange Commission (SEC) and the money borrowed by the fund and shares sold by the fund would pay cash for ALL the land everywhere in one big fell swoop transaction!! No real estate agents, no traveling, no PR firms spread all over the U.S. to contend with, just one huge, happy, payday for the property owners. Of course, it actually took an act of Congress to make it all come true, but that actually happened in 1960, just two years later. So, while the payday for our investors was delayed a bit, it was still a big and far less complicated one when it finally came.
[Editor's Note: 5 Ways to Profit From the Housing Bust.]
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Thus was born the Real Estate Investment Trust (REIT) business. It certainly saved the original investors a lot of trouble, but more importantly it opened the door to one of the most profitable business forms that Wall Street ever created.
In 2006, the average (remember average) public REIT returned over 34 percent profit to its investor, better than twice what the Dow Jones returned, by the way. But, we all know that real estate is going through a pretty big correction right now after years of boom times.
However, the real estate bust is concentrated in residential real estate, or houses, not in commercial real estate. So, there are still a lot of opportunities to be had out there.
Fortunately, in the last 46 years, the scope of the REIT has broadened a great deal. Instead of being limited to just land as an asset, REITs now include not only land, but residential homes, shopping centers, office buildings, apartment buildings, industrial buildings, mortgages and even, strangely, timber companies — more on those is a moment.
So now let's look at the types of REITs available, the way to invest in them, and a few hints on where you might start your own research to invest in these REITs.
Let's begin by looking at the structure of REITs. REITs are basically mutual funds registered with the SEC under the 1960 law passed by Congress (amended a number of times of course — most recently in 2001 with the REIT Modernization Act) — and, in most all cases listed on a stock exchange and traded in the form of shares. As such, they are required to issue earnings reports, pay dividends, report important news about their activities, and distribute quarterly and annual reports.
Note: Let me add here, just for the record, that there are many non-listed private REITs, ones owned by a small number of investors and not offered to the public at all. But, these are of no interest to our discussion. I just didn't want to ignore them. If I had, I would likely get a deluge of e-mails telling me I really goofed by not mentioning them.
REITs offer a most unique way for the average small investors, especially those not in the real estate business, to purchase an ownership position in large commercial projects that would otherwise never have been available to them in any other way. It is an ideal way to partially diversify a portfolio into hard assets, but doing so on a much smaller budget.
REITs generally fall into three categories: Equity REITs, Mortgage REITs, and a very small handful of what are referred to as Hybrid REITs (ones that are a combination of the first two).The Equity REIT makes its income from rents, leases, etc. on properties it owns. By the way, to officially be a REIT you must have 75 percent of your assets in real estate, as well as distribute 90 percent of your yearly earnings to the shareholders of the REIT (most REIT funds pay out 100 percent and the shareholders are then responsible for paying the taxes due on all distributions, including dividends).
[Editor's Note: This ETF Service Bagged 70%+ Gains as Housing Prices Dropped.]
You can buy shares of REITS just like you do stocks of any public stock company and this allows you to compile a portfolio of REITs to fit almost any goal that you have set. For example, maybe you want to participate in the commercial end of the business because you have more knowledge of this area. Very possibly you are a contractor or work for a contractor that builds shopping centers, but don't have the funds to be a part of the developer's group. Easy enough to fix. Just determine what portion of your portfolio you will put into REITs that build shopping centers, get their quarterly and annual reports, do a bit of research on the internet (if you are so inclined) and your own expertise will soon tell you how to be part of four or five big projects spread all across the country — thus dispersing your risk across many retail markets and buying protection from local economic downturns that even your developer employers can't buy
However, I recommend that you not exceed 30 percent of your portfolio in REITs, as stocks should always be your prime investments (for more details on why, see my recent article on mutual funds in my archives. Go to MoneyNews.com > Expert's Corner > Income Investing with Max Whitmore).
Or maybe you want to spread your REIT investments risks out even further, into a combination of mortgages, residential real estate, industrial land, and even timber (more, as I said earlier, on those in a minute).
Whatever your choices, somewhere there is clearly a REIT to satisfy your needs.
By way of information only, out of the many hundreds of REITs there are 13 REITs in the S&P 500, as of this writing. While I am not recommending any one of them specifically, I will say that as they are part of the S&P, in my book they should be considered as good candidates for your portfolio. All are listed on the New York Stock Exchange, which requires stringent qualifications to list any stock or fund.
Look at each of them and make up your own mind how they might fit your income investing needs. Give special attention to their dividend payout. Every income investor needs to do that. Then, if, after doing all your footwork, it is still too tough to make a selection, e-mail me your specific questions that stand in the way of making a decision and I will do my best to see you get an answer either by e-mail or via one of my columns.
For the record, the S&P companies, listed alphabetically are: Apartment Investments (AIV), Archstone-Smith (ASN), Avalon Bay Communities (AVB), Boston Properties (BXP), Developers Diversifed (DDR), Equity Residential (EQR), Host Hotels and Resorts (HST), Kimco Realty (KIM), Plum Creek Timber (PCL)— see I told you there were timber REIT's), ProLogis (PLD), Public Storage (PSA), Simon Property Group (SPG), and the Vornado Realty Trust (VNO). Background and financial reports are available on all of them from your broker or on the internet.
Now, you may be asking, are there any downsides to REITs. Yes, true, there are some you need to be aware of before you invest your hard earned cash. For example, you want to be very aware of where the REIT you like invests their funds. Is it in a large metropolitan area that might be subject to overpriced real estate? If so, be careful because if there is a pause in real estate investing (like we are seeing today) your share value may go down as traders sell fearing reduced property values, lower income from commercial property as vacancy rates climb, and higher losses from mortgage foreclosures caused by a weaker economy.
[Editor's Note: Expert: Residential Real Estate Will Fall 20% to 40%.]
Also, be aware of the tax angles. I don't give tax advice, so get that from your friendly accountant or tax lawyer. I only warn you to ask them about what are called "qualified dividends" received by REITs investors. You might be facing a problem where part of the dividend you receive will be taxed at the higher ordinary income tax rates and not the lower dividend rates.
And remember, you will be required to pay the taxes on all distributions you get from your REIT, whether you take it in cash — in which case you have funds to pay the taxes due — or reinvest the distributions — in which case YOU have to come up with the cash for taxes due on the distribution. Be sure your REIT does not penalize you for withdrawals you might make to pay the taxes on received distributions. Most don't, but always read the fine print. (Where have you heard that before? I hope not from your attorney.)
And remember, if interest rates climb, your REIT share prices will likely suffer. Higher interest rates mean higher costs of operation and thus lower profits. And investors don't like lower profits. So, be alert to this downside by checking your share price movement if rate hikes are being considered by the Federal Reserve.
Well, that's about it for today. Oops. Almost forgot — the timber REITs. I told you of the Plum Creek Timber REIT listed on the New York Exchange. It wasn't until 1999 that the first timber company (Plum Creek Timber it was) stumbled on using the REIT to really enhance their ability to buy more property to raise timber upon. Their innovation was unique and got a lot of attention because it allowed the timber company to raise more cash to buy more property to plant more timber, which enhanced their long term future income potential, which caused new investors to buy their stock — which made Plum Creek shareholders very happy.
Of course, the investors in Plum Creek got a good deal, too. Planting timber is a very low cost operation. Saplings are cheap. Left alone for a number of years they grow into expensive lumber without any additional investment needed, totally unlike any other REIT where buildings need constant big dollar investments in upkeep and replacement. In the end, the investors loved it as this enhances eventual earnings over all other types of REITs. And in the end, Plum Creek became part of the highly prestigious S&P 500 stock group. Not bad. Not bad at all!
So, that really does do it for today. Do hope your coming investment week is a good one. In the meantime, you keep in touch. I do. See you next week.
Editor's note:
Expert: Residential Real Estate Will Fall 20% to 40% -- Go Here Now
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